It's the margin!

Chuck Schwartau

Published in Dairy Star December 16, 2010

Most people are thankful another election cycle is behind us. A frequent subject of recent elections has been the economy. A commonly heard response when candidates were asked about issues was “It's the economy!”

While the economy is still on the minds of many farmers, we should be starting to think in the more specific concept, “It's the margin.” Farmers look and listen for market prices on a regular basis. Some have radios tuned to stations with lots of market reports, or have web pages bookmarked for quick, up-to-the-minute market reports. Those reports are valuable for making marketing decisions, but they only cover part of the profit equation necessary to realize a profit. The cost side needs to be subtracted to determine the margin that the farmer has for paying the bills and keeping the operation in business.

If a cash crop producer wants to work for a particular margin, they can pretty well determine the majority of their input costs and watch the market for pricing opportunities to achieve their goals. For dairy producers, input costs keep changing unless they grow every bit of their own feed and the milk price moves every month. This makes margin planning a difficult process.

A relatively new product available to dairy producers (first available in 2008) is the livestock gross margin-dairy (LGM-D) insurance policy. LGM-D is like a crop insurance policy but is specific to dairy. The biggest hurdle to getting more operators using this policy is changing their thinking from milk price to gross margin. The idea of insuring a margin, regardless of the milk price, is a bit foreign.

The policy uses futures prices for milk, corn, and soybean meal on specific days each month for income and feed cost calculations. The producer is able to input ration amounts, with all feeds automatically converted to corn or soybean equivalents for their energy and protein contributions to the total diet. With these inputs, an estimated gross margin for each month is calculated and a premium cost determined for various protection levels. Producers can then use this information for deciding whether or not they want to insure any given month's estimated margin.

During the period that the policy is in force, the price of milk, corn, and soybean meal might move all kinds of directions and have little resemblance to the prices at the time of the original calculations. But if the actual gross margin at the maturity of the policy is less than what was guaranteed, a settlement check will be issued. If the final actual gross margin is higher than the policy insured, the policy simply expires, just like any other insurance policy. While this may seem funny, you really are a winner any time you do not collect on your insurance because the profit margin was higher than predicted.

The USDA Risk Management Agency (RMA) has made some recent changes that make gross margin insurance more attractive to farmers.

Premium payments may be made at the end of the insurance coverage period. Up until now, one had to pay the premium at the signing of the contract so this is now more like crop insurance.

There is a premium subsidy available of 18% to 50% if you insure more than one month.

The maximum deductible will increase from $1.50 to $2.00 per hundredweight. Higher deductibles allow for lower premiums.

The new product increases the amount of corn and soybean meal equivalents that can be included in the premium calculator to cover the feed for the whole herd. By using available feed calculators, producers will be able to calculate the equivalents of corn and soybean meal necessary to feed their youngstock as well as their milking herd. This is so they can cover a greater portion of their total risk incurred by potentially rising feed costs and reduced milk prices.

A key component for making a gross margin insurance decision is to know what margin is necessary for your farm to be profitable. It is an unfortunate fact that far too many farms do not know their real cost of production. If you don't already have a good recordkeeping system for your farm, this is the time to get one. While simple, hand-kept systems may be inexpensive, today's business management needs may not be met by that simple system. The investment in proper accounting software and/or a system that has an advisor or supervisor involved could be a good investment in the long run. It will enable you to determine accurate margins of your current business and set targets for the future that are reasonable and attainable.